FxWirePro: Yen specials - Short JPY against USD, EUR and CAD based on yields and valuations

In this write-up, we emphasize on yen trades (especially short JPY against USD, CAD, and EUR) from the fundamental perspective.

If you consider from last one-year trend, yen seems to have been losing momentum completely. The dollar has been in the mood of extending its gains against yen about 12.25%, while CAD gained against yen over 18.7% in this span. EURJPY spiked more than 19.1% since last October

USDJPY – limited by yields, challenged by valuations: The USDJPY chart is fluctuating between two converging lines at 115.50/116.00 and 107.50/106.50 which could potentially be forming a triangle pattern. This fits our concern that we’re unlikely to return to the 2015 highs.

A higher USDJPY relies on US TIPS yields breaking free; we think a test of December’s peak is possible but a break higher is unlikely. It’s also increasingly apparent that yen bears can’t rely on a risk-friendly backdrop alone to help them, given unhelpful cross-currency basis spreads.

We’re happy with long USDJPY during the current rising trend in TIPS yields but we’ve lost almost all hope of seeing 120 again and there’s a long-term danger of a move lower, towards PPP-consistent levels closer to 100. 

The Bank of Canada has started to normalize monetary policy as an offset to a hot property market, and the CAD has recovered in recent months. But it’s still cheap relative to AUD and NZD and relative to the USD. Meanwhile, an inverted Head and Shoulder pattern at the decadal support line makes CADJPY the most definite bullish configuration among Yen crosses 

Both EUR and JPY are undervalued against the US dollar because getting (and keeping) the currency down has been a policy priority of both ECB and BOJ. Europe’s economy is recovering a little faster than Japan’s and inflation expectations have moved further away from zero, which has allowed the ECB to shift its focus towards slowing bond purchases and normalizing policy far sooner than the BOJ will. We’ve seen EURJPY rally sharply but the current correction offers a chance of a second bite at the cherry. We’re looking for a test of the post-1980- resistance line at 141. 

The first chart shows the spread between TPS and JGBs, against an inflation-adjusted USDJPY. Abenomics and BOJ policy took the yen from very overvalued levels to undervalued ones and has kept it there. It’s not obvious if keeping there would have been possible without a recovery in US Treasury yields in both real and nominal terms, outright and relative to JGBs.  As with the ECB, the BOJ will in due course shift focus towards policy normalization but for now, inflation expectations are still much lower (0.3%) than in the US (2.3%) or the Euro area (1.6%).

The measure of USDCAD PPP is around 1.15, suggesting there’s some more room for CAD to out-perform the US Dollar. More importantly though, now that Alberta’s economy has stabilized, the bank of Canada is focusing on policy normalization and taming a (too) strong property market. Canada escaped the worst of the global financial crisis has no domestic (non-FX) need for emergency levels of rates. Getting CADJPY back to the previous peak levels in real terms would see spot around 100.